Page last updated at 12:29 GMT, Wednesday, 4 March 2009

Rate cut a 'savage hit' to savers

Monopoly piece on coins
Savings and mortgage rates have dropped rapidly in recent months

Savers would face another "savage hit" if the Bank of England cut interest rates again on Thursday, the Building Societies Association (BSA) has warned.

The BSA, which represents 55 building societies in the UK, added that a Bank rate cut would restrict new lending to the depressed mortgage market.

The Bank rate has fallen five times since October, is now at 1% and is predicted to fall further.

The cuts were made to try to boost the shrinking economy.

Following last month's 0.5 percentage point reduction, the Bank of England said that the rate cuts, along with government measures to boost the economy, "would provide a considerable stimulus to activity as the year progressed".

Pensioners hit

The effect of these reductions, according to the BSA, was more pain for pensioners who were relying on the interest from life savings as an income during retirement. The returns on these savings had been slashed, meaning pensioners had to eat into the lump sum.

For and against: Tim Ross, on a tracker mortgage and saver Gloria Harris

"They now find that a lifetime of saving has not delivered the standard of living they had every right to expect until a few months ago," said Adrian Coles, director general of the BSA.

The latest figures from the Bank of England show that the returns paid on the most common type of savings were at record lows in January.

Branch-based instant access and notice accounts (averaging 0.29% in January), tax-free ISAs (1.38%) and fixed-rate bonds (2.35%) - when savers commit their money for a set period of time - were all offering the lowest rates since records began, the official data showed.

Those figures do not take into account cuts following February's Bank rate fall.

One academic suggested that cutting rates even further could create a backlash from savers.

"As deposit rates fall toward 0%, savers have precious little incentive to keep existing deposits at banks, never mind increasing them," said Shelagh Heffernan, Professor of Banking and Finance at Cass Business School.

"Distrust and hostility could prompt depositors to withdraw their funds and hoard cash. Such behaviour could seriously aggravate existing problems in the banking sector and the broader economy."

Figures from the British Bankers' Association (BBA) showed a 2.2bn fall in personal deposits with the major banks in January. The BBA suggested that this was due to people moving their savings from ordinary savings accounts to alternative assets which offered bigger returns.

However, National Savings and Investments, which has a 100% guarantee on the safety of savings, has just reported a large inflow of funds in the last three months of 2008.

Mortgage effect

The flipside of the Bank rate falls has been lower mortgage repayments for most householders with tracker home loans.

8 October 2008: 4.5%
6 November 2008: 3.0%
4 December 2008: 2.0%
8 January 2009: 1.5%
5 February 2009: 1.0%

In the UK, there are fewer borrowers than savers, but the total debt of borrowers is much greater than the total deposits of savers. So cutting interest rates saves borrowers more money than it costs savers.

The Bank and the government have been hoping that people spend this extra cash.

However, the Building Societies Association argues that the inability of financial institutions to lend is preventing other spending.

It said that these institutions would struggle to attract savers if rates were cut again. Declining profit margins resulting from ultra-low interest rates further restricted their ability to lend.

Andrew Hagger, of, suggested that the government alter rules on ISAs in the light of low interest rates to offer an alternative to savers.

He said the overall limit should be increased from 7,200 to 10,000, and that all of this allowance could be put in a cash ISA, unlike the current limit of 3,600.

David Kuo, of The Motley Fool financial website, said savers could look to long-term investments on the stock market for better returns - although there is always the risk of investments, unlike savings, going down as well as up.

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